How Low Interest Rates Increase The Value Of Income Producing Assets

There was surprisingly little debate regarding my passive income investment rankings. Figuring out the five factor scores for each of the seven investments took about 10 hours to produce, so perhaps I was thorough enough to address all the points. Everybody agreed that dividend investing is one of the best ways to generate passive income. The two main investments that had the most discussion were Real Estate and Creating Your Own Product.

The pushback on real estate investing is that it feels too much like work. When you’re trying to find the perfect tenant and keep up with property taxes, real estate can feel like a bear. Meanwhile, nobody disagreed with Creating Your Own Product as being a top passive income generating asset. However, I just didn’t get the sense that anybody really got motivated to start creating something.

In this short post, I want to demonstrate via some charts and logical reasoning the power of purchasing rental property and creating a product.

HISTORICAL INTEREST RATE CHART

First, I’d like everybody to take a look at the 10-year Treasury yield from 2005 to 2015.

As you can tell from the chart, the 10-year bond yield has fallen from around 6.3% to around 2% in 2016. Some reasons for the fall include: the Federal Reserve lowering the Fed Funds rate, declining inflation, improved monetary efficiency, economic slack, the continued global demand for US assets, and relative stability in the US vs. other markets. Bond yields have actually been falling since July 1, 1981 when the 10-year yield was at 15.84%.

In a declining interest rate environment one must invest more capital to generate a fixed amount of income. Declining interest rates are a big problem for retirees who have investments in annuities, bonds, CDs, and dividend stocks because everything is relative to the risk free rate. A bank isn’t going to issue a 10% yielding CD, when the bank itself can only earn 2.5% on its money! A corporation isn’t going to pay an 8% dividend yield unless it has completely run out of ways to reinvest its earnings.

Take a look at this chart I put together highlighting income streams from real estate and a product.

At a 6% interest rate, it takes only $917,000 and $333,333 in capital to generate $55,000 in rental income and $20,000 in eBook income respectively. If the interest rate falls to only 2% as we have now, then it takes $2,750,000 and $1,000,000 of capital to generate the same $55,000 in rental income and $20,000 in eBook income!

Put it another way, if you are the owner of such real estate and eBook, you’ve seen the value of your asset rise by 500%! A persistent decline in interest rates has generated a lot of wealth for income producing owners.

To calculate the values in each column, simply divide the income stream by the interest rate.

WHAT’S HARDER TO DO? SAVE OR CREATE?

Let’s say the Real Estate Rental produces the same $20,000 a year in annual income (after all expenses, pre-tax) like the FS eBook. In my simplistic model, based on the current risk-free rate of 2%, the value of the eBook and Real Estate Rental are both worth $1,000,000.

To buy a $1,000,000 home will require a $200,000 downpayment and an income of roughly $200,000 a year if we apply a 4:1 ratio on mortgage to income at today’s rates. It’s not particularly easy to make $200,000 a year. Even if you do make $200,000 a year, you might not have much left in disposable income. (See: How To Make $200,000 A Year And Not Feel Rich) Even if you do make $200,000 a year, it will take a while for the average person to save up $200,000 in after tax money for a downpayment.

Now let’s talk about creating a product. It took me about three months of spending at least five hours a day writing my 100-page severance package negotiation eBook. The book then went through over 20 revisions with the help of my father and my best friend. I then had to spend several hundred bucks on design and packaging work. Finally, I had to pay $55 to register my book with The Library of Congress and $295 for 10 ISBN codes.

One can say I wouldn’t have been able to write my book if it hadn’t been for my years of experience working in Corporate America. But the book was an X Factor, because I was going to work for years in Corporate America anyway. I wasn’t working in Corporate America in order to try and write this book! I was just diligent enough to take copious notes during my severance negotiation process and actually create something.

In other words, I think creating your own product that generates $20,000 a year is a much easier than trying to make $200,000 a year in income, save $200,000 for a downpayment, and then buy and manage a property that generates $20,000 a year.

DON’T FORGET THE RISK PREMIUM!

Of course, my interest rate model in the chart above is simplistic. Nobody is going to invest $2,750,000 in a property that generates $55,000 for a 2% return when they can invest $2,750,000 in a 10-year Treasury bond for a 2% return and do nothing. There needs to be a risk premium to compensate the investor for taking on the risk and hassle of owning such a non-risk free asset.

The risk premium is why there’s a market for assets. In a bull market, the risk premium collapses, because people are risk loving. They believe the risk for a downward change in value of the asset or income stream is small. In a bear market, the risk premium widens. Let’s say we’re seeing a rise in the unemployment rate and Congress passes an act that completely removes the mortgage interest deduction for ALL income earners. Clearly, the risk premium would increase for property.

In a very real way, even our jobs have become more valuable in a declining interest rate environment if you can find one that pays you a steady or ever increasing amount. The problem is that everything is Yin Yang in finance. I believe income producing assets are undervalued due to this egregious fear that interest rates will soon skyrocket. As more people believe the way I believe, prices of such assets increase in value. Therefore, use your steady day job income to invest in as many income producing assets as possible.

Since 2003, I’ve taken a stance that we will be in a low interest rate environment for years. I continue to believe that low interest rates will stay for years to come. Even if the Federal Reserve raises the Fed Funds rate from 0.25% to 2%, interest rates are still low and what’s more important is following the market (Treasury yields). The good thing about technology is that it has enabled us to do more with less.

The real question is: will you actually take action to improve your financial future? One of the best ways to create semi-passive income is to start a lifestyle business with a blog. It’s never been easier and cheaper to start your own website and leverage the 3 billion people on the internet. Once you build your brand online, you can find plenty of consulting work, new full-time work opportunities, earn revenue by selling your own product or someone else’s product, and even earn advertising revenue. Not a day goes by where I’m not thankful for starting Financial Samurai in 2009. If I didn’t, I wouldn’t be free now!

A real income statement example from a blogger. Look at all the income possibilities!

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About the Author: Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $210,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies, and writing online to help others achieve financial freedom.

Author Bio: Sam started Financial Samurai in 2009 to help people achieve financial freedom sooner, rather than later. He spent 13 years working in investment banking, earned his MBA from UC Berkeley, and retired at age 34 in San Francisco.

Sam’s favorite free financial tool he’s been using since 2012 to manage his net worth is Personal Capital. Every quarter, Sam runs his investments through their free Retirement Planner and Investment Checkup tool to make sure he stays financially free, forever. It’s free and easy to use.

For investing opportunities in 2019, Sam is most interested in investing in the heartland of America through real estate crowdfunding. Property valuations are much cheaper and net rental yields are much higher. There is a demographic trend towards moving away from higher cost areas of the country to lower cost areas thanks to technology.

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Comments

First and foremost, any passive income stream should be pursue in my opinion. Why leave an option on the table when you can have them all. That being said, while I understand your argument about creating a product that would produce $20k a year in passive income, I don’t think it is the fairest comparison with real estate the way it is described.

For one – people outside of San Francisco can easily purchase a multi-family for less than half a million dollars, which will typically generate a healthy amount of income. So assuming it is a 3 family for $500,000, putting the down payment amount at $100k, $100k salary job – I think it is a relatively realistic scenario. (Of course then you have to consider the fact that rental income would also be less, but it is easier for someone to get their foot in the door compare to your $1 mil property scenario)

And then there’s the fact that income will likely grow as rent increases, yet mortgage payment does not. As long as the revenue keep pace with rise in maintenance cost, taxes, and insurance, for the most part, the income will grow.

Creating a product on the other hand, depending on the product, could fall out of favor with the market. The $20k you are able to generate on the book may not require much work now that you are done with it. However if I have to guess, the amount of money it will bring in 20 year down the road would not be what it is today.

More importantly, real estate is a source of passive income that can be scaled in a way creating a product may not be able to. If one is diligent about saving money, they can repeat the process to own additional properties. Even if I am able to follow your model to create a product by spending 5 hours a day for 3 months straight, I am not sure how many times I can do it before exhausting all of my options.

But then again, like I said at the beginning, why leave any options on the table for passive income when you can do it all.

* Buying a $500,000 home, saving $100,000, and making $100,000 is more feasible than the $1M, $200K, $200K option, but the rental income on the $500K income will be proportionately smaller.

* Real estate and your product could both fall out of favor (financial armageddon in 2008-2009). If my book was around during the crisis, I think sales would have SOARED as people saw the writing on the wall and tried to maximize their exits.

* A ebook or infoproduct can be updated with new chapters and rereleased (uploaded) very easily. Real estate needs constant maintenance and ongoing property taxes to pay.

* Can real estate be scaled differently than a product that has the theoretically demand curve of millions more people? Why can’t one product be scaled to produce a series of similar products under one brand name e.g. The Financial Samurai’s Guide For Getting A Job, For Investing Like A Pro, For Engineering Your Layoff, For Building A Real Estate Empire, For Developing Multiple Income Streams, etc?

* If you try harder with your product, you will likely sell more. If you try harder with real estate, there’s less you can do.

I love real estate. But I’ve grown to love Creating Products even more.

Everything is easier for talented people. I can’t create an ebook, much less updating it with new chapters and rerelease. If I write a book, my family wouldn’t even buy it. But everyone can save money and buy a property. So I think real estate is more doable for the average person.

Different people will have different difficulties in creating products. It is important not to rule anything out as being too difficult, and let our own negative mentality become the biggest hurdle we need to overcome. That’s my biggest take away here.

Awesome post! I just wrote my first book on working out and I plan on writing a second. I tried to explain to people that $100 in sales every month is the same as give or take a $20K CD paying 5%, but it always fly’s over their heads…

These last two posts have been excellent Sam. I’m having this asset allocation debate with myself right now. I’ve checked the boxes of index funds, real estate, annuities, dividend stocks, p2p lending. Now I’m really starting to open up to the idea of creating products that provide revenue streams as a way to diversify. The trouble is that this get into the issue of time allocation. I work long hours at a high paying and rewarding job. It may not be what I want to do for the rest of my life, but it’s certainly interesting now and it gives plenty of opportunities for growth. One of the reasons that I don’t want to take on more real estate right now is because rentals are never truly passive and they start to eat into my time. I feel the same way about creating a product.

How much long term maintenance have these projects required once the initial hard work is complete?

Regarding your comments early in the post about nobody seeming excited the create their own product for passive income…Here is my question/reservation:

How much of the success of your eBook product do you attribute to just that product itself, rather than to the massive traffic you have built for this blog?

In my mind, it seems the success of the eBook took much more effort than just creating the eBook. It also took thousands of hours of hard work in building this blog so that you had a massive readership to offer the book to, which then created word of mouth, etc. Also, the relationships you’ve built through the blog over the years created opportunities to guest post about the eBook on other blogs to gain a wider audience.

I am in no way trying to discredit what you’ve done with the book or the blog – quite the opposite.

However, in the case of a person like me without a large blog readership, would it make sense for me to invest a ton of time creating an eBook if I don’t have a platform standing behind me from which to market the product?

I am guessing most people are closer to being in my situation (no marketing platform already in place) versus being in your situation (massive marketing platform already in place).

From where I sit, creating the online product doesn’t seem quite so passive. I have a couple ideas for eBooks/products that I think would be excellent quality, but I worry about putting in the time to create the products and not having a channel to sell them.

1) My book sales of ~35 a month is a disappointment. The book sales have only risen about 30-40% on average a month since launch, but my site’s traffic has more than tripled since 2012. As a result, I wouldn’t attribute my book sales much to any thing I’m doing on FS. However, I would attribute my advertising revenue’s growth based on the effort I’ve put in to this site. The upside is that the book sales can be viewed as that much more passive.

2) If you think you need a large platform, then you will never create. There’s a chance once you create, then you will bring in the traffic! After my book was unleashed to the world, I saw a 25% permanent step function increase in FS traffic. Whether that is a coincidence to a Google algo update or not, I’m not sure. I am sure my book gets pirated more times than I’m able to sell it.

3) The biggest hurdle is the first hurdle: trying. Once you try, you may fail. But if you do, you’ll learn so much more as to increase your success the next go around!

A bit off topic, but have you thought of compiling some of your core posts into a PF book? It seems that a lot of bloggers do this with great success. You’ve already done the work, just put it into a manageable package for folks that would like to just read a book.

I think the most important assumption in this entire post is your stated belief that we will be in a low interest rate environment for years. I am older than you so had the privilege of living through the Jimmy Carter years with +15% inflation rates, et al. In that version of reality, up is down, black is white, etc.

With $18T in debt and a projection to be at $20T before Obama is done, how are we going to repay all that debt. We can confiscate 90% of “rich” people’s income and its still not enough. (not to mention that they’ll all just stop working if that happens). So the only way to get rid of the debt is to inflate it away. Repaying $20T gets easier when $20T is no longer “worth” $20T. If this happens, interest rates will adjust upwards to accommodate.

What is your reason for believing this won’t happen and rates will stay low for a long time…?

I have the same mind set as you, but several things have happened that throw what I’ve learned.
1. We’ve been keeping the interest rate low for 6 years now. We did QE. Our budget deficit is too high, we got to raise interest rate and taxes at some point to compensate for it. Just when we get into the mind set of raising interest rate 2012-2013. The Yen got too high, it hurt the Japanese economy. So, they did their own version of QE. The Yen moved from 90 yen to a dollar to 110 yen, now 122 yen a dollar.
2. In between, we have the EU crisis – Italia, Spain, Portugal, and especially Greece. The Germans keeps printing money to bail these country out. Then they have to do their own QE.
3. Our neighbor, Canada, is kicking their own QE.

As the result, we have a currency war. Our dollar is worth a lot more against the Euro, yen, Canadian, Australian,etc. The Chinese has been playing the currency game since the 90s, their economy is growing 7-15% during the recession. Therefore, it hurts our export and slow down inflation. Now, if the FED decides to raise interest, and the administration raising taxes, the dollar will be worth even more. It will definitely hurt us.

That is why the headline still say “patient” and “dovious” FED… :P
It seems like the rate will remain low even the talk of increase interest rate since 2012, but the FED hasn’t made any move, and probably won’t.

The 10-year yield could increase by 100% to 4%, but that’s still low. If rates increase, that’s a sign of tremendous tightness in the economy, strong wage growth, strong job growth, and therefore strong asset price growth.

The USD is the world currency. We are the most stable country in the world. As countries like China and India continue to grow, they will increase the purchase of our debt. It’s all about capital account recycling.

The markets and Central Bank around the world are much more efficient and smarter now thanks to technology and history. Only time will tell if I’m right. And if there’s runway inflation and sky high interest rates back to the Carter years like you say, then I hope to have the assets to inflate with inflation and the cash to buy assets in a decline.

I’m happy to make a wager with you for whatever amount you feel comfortable that the 10-year yield will not be over 4% by the end of 2016.

Sam – I wouldn’t pretend to be able to know where rates will be in the next 1 to 2 yrs….,but what we all need to worry about is where they will be in the next 5 to 10 yrs…..And as I said above, there is a lot better chance they will be significantly higher than lower….and while you provide a laundry list of some “good” reasons they might go higher (traditional tightening, etc). the real reason we will be forced to raise them is to inflate our $20T of debt away. And while this isn’t fun to acknowledge, I see no alternative. Do you?

No problem. Happy to bet on a 5 year horizon about rates too. Let me know where the rate is on the 10-year yield will be. Where do you think they’ll be and what investment changes are you making to take advantage of significantly higher interest rates?

Sam – Generally speaking, if you chart 10 year treasury rates against the S&P over the last 100 years, you’ll note that as rates go up, asset prices come down. And vice a versa. Some of the reasons for this are pointed out in your above post.

Many (including me) believe the reason that both stock prices and real estate prices are currently trading at historically high valuation ratios is tied to the Feds current “experiment” in holding interest rates at almost zero for half a decade and running….

This experiment has helped many since 2009. Stock investors and real estate investors alike are now claiming to be trading geniuses. Politicians are racing to take credit, etc.

Unfortunately however, markets haven’t arrived at their current heights based on free market principles. They’ve been manipulated. And there will be consequences. One being, that we have to figure out what to do with our nations $20T in debt.

I can’t provide an interest rate “glide path” because it will be governed by politicians with varying agendas. But I can tell you that if not for QE1, 2 and 3, interest rates would now be dramatically higher. So one can only assume that as the historical intervention is removed, we’re going to see a spring back to where they “should” be….

As for what to do about it, as I’ve shared in an earlier post, I’ve reduced equity exposure to the very low end of my range at 40%; and invested the balance in short duration bonds and 5 yr CD’s with acceptable EWP’s. As Buffett said well in another context, I don’t want to have to rely on the kindness of strangers when the tide again recedes.

I’ve actually written why I think rates will stay low many times in previous posts and comments before. But here are some reasons again:

* Information efficiency
* Economic slack
* Coordinated central banks
* The dominance of China and India and their increased purchase of US debt
* USD and US assets as a continued safe haven
* Rates have been going down for 30+ years in a row, the trend is telling us we’re more adept at managing inflation with each new cycle

Would you possibly want to write a guest post about your beliefs on why you think interest rates will rise and how to profit from it? I’d love to have it.

As someone who trades interest rates for a living (interest rate swaps/swaptions/Treasuries/MBS) I fully agree with Sam’s assessment of “low for longer” rates.

A lot of people are of the mindset of EarlyRetired, but unfortunately in this instance your hindsight is actually working against you. Everything is different this time than in the past for the reasons already mentioned 1) Strong dollar/world’s reserve currency 2) Lower potential growth 3) More effective monetary policy 4) Globalization

I will tell you right now that there is a much higher chance that US 10 year notes hit 1% than 4% in the next 5-10 years. I plan on buying a house soon and plan to get a 7-1 ARM. Take advantage of this view now before it become commonplace in the next 1-2 years!

I agree with earlyretired, I am not sure that interest rates will remain low past the next couple of years without some adjustment to government spending.

That being said, I appreciate the idea that as itnerest rates go up my hard work from saving a lot of my income pays off even more than it already does. It serves as a motivation to just keep saving and not worry about some of the other factors that are outside of my control.

We never know what we’re fully capable of unless we try. Creating a product takes a lot of work up front, but as you and others have shown it can be done and it can do quite nicely as a passive income stream. I like how you analyzed rental property and creating a product. And yes, great points about risk premiums.

One of my big goals is to create a useful, helpful product and earn some income from it, and I continue to make very slow but incremental progress on this front. However, I’m struggling with the opportunity cost of it all. Many people (including myself!) are often telling me to put my energy into searching for a new, higher paying job, or pushing myself much harder at my current workplace for a promotion and work towards becoming a partner. This definitely has much greater potential, even if longer-term I will get much more satisfaction instead from my own creative achievement, but it’s highly likely to earn very little in the long run relative to career advancement.

Of course, the obvious answer is to do both! But is it really worth the opportunity cost of developing your own product when there’s so much career earning potential ahead? And when this extra income can be funnelled to passive income assets like dividend stocks instead? Do you perhaps wait until you have enough passive income from other sources like dividends to take a break from the career to then support your ‘product developing’ investment?

Thought I’d comment for the first time as I really enjoyed this post. I’m an avid real estate investor – so my opinion is clearly biased. ;)

A few things I’d like to mention:
1) Creating something like an eBook doesn’t generate me any tax-advantages, and I have no depreciation options to reduce my taxable income
2) Leverage and gain of equity. I can’t leverage an eBook like I can real estate. Equity grows over time, allowing more and more capital available.
3) Rental prices go up. Raising the price of the book may have an negative effect in your sales if you raise it.
4) You’re assuming you have to use your own capital to buy real estate, you can always use OPM (other people’s money).
– Example: I find the deals, I hire the property manager, I find investors – offer them an X% return on their $$ (6-8%, typically depending on the deal). I use their money for the 25% down, structure the agreement so that I get X% of the equity and income (30% seems to be the sweet spot), they split the remaining X% between each other and they each receive a percentage of the property.

These are just a few of my opinions, but my point is – your $20,000 from an eBook and $20,000 from real estate is not an apples to apples comparison. That $20,000 in income from real estate will actually generate me additional equity, and I can depreciate the asset, thus increasing my net worth more than the $20,000 from an eBook would.

But have you tried to create a product? If not, how do you know there is not leverage? After I published my eBook, my site’s traffic went up 25% and stayed that way for the rest of the year. The synergies were that people read/stole/bought the book, came to my site, told their friends, and more people came. The site’s traffic has tripled since, and revenue has also tripled. I would say that’s leverage to me, without having to pay property taxes and other maintenance costs.

If you can convince other people to give you their money and make money off them, then that’s a beautiful business model. I’d do that all day long b/c you essentially now have no risk, except for your time and reputation.

Someone said once that you make money in real estate by selling in a low rate environment and buying in a high rate environment. I thought that certainly left a lot of holes for outlier scenarios but, I saw his point.

I noticed that when you google Greenspan google tells you that people also searched for “Bernanke, Volker, Yellen and Ayn Rand”. cue twilight zone music.

I lived through double digit inflation too. I understand where he is coming from.

I can’t see that (but anything is possible). The fracking technology is probably good for at least decade or two for stable energy prices. Eventually the oil will run dry. It is finate amount of product. I’m thinking technology will help move us beyond oil much more by that time (electric cars. Tesla, etc.).

I live in a low almost deflationary enviroment (Europe) and was checking out some retirement software and something keep throwing me off, took me a bit to figure it out but it was inflation, like WTF is that and then I remembered I lived in Spain during the housing bust and now in Germany with negative real interest rates and I’m simply not used the idea that prices increase each year simply because time goes by.

“The world can only support so many ballerinas!” – Don Draper’s mother-in-law

FS, I’m sure the main reason there was ‘surprisingly little debate’ on the ‘passive income investment rankings’ was because there was no criteria. Without that criteria, what is there to debate? The one gap that stood out to me was the ‘Liquidity’ Score of ‘Fixed/Bonds’ at 8, while CDs scored 4. Not sure what the difference is between Fixed and CDs, and CDs can be liquidated in a day with (at most) an interest penalty of six-months interest. That 4 points is substantial in your overall rankings. Can you explain?

The main thing in this post that attracted my attention was your assertion that “creating your own product that generates x a year is a much easier than trying to make 10x a year in income, save 10x for a downpayment…”. You have done a great thing with your eBook, and it paid for itself 1,000-fold in my case. Can you repeat this success with another eBook?

I would respectfully disagree that ‘creating’ is an easy way to money. Creating is one thing, creating something people will pay for (especially in today’s culture of “free”) is quite another. The sheer value of the time spent in creation (writing a song? writing a book? making art? online guitar lessons? a comedy podcast?) is subtracted from one’s life in zero-sum. My thought is most people aren’t creative, those that are will not create anything worthy of substantial remuneration, and that most people’s time is best spent in labor-for-money if money is the goal. Not discouraging anyone from trying, but it will be interesting to see if there are any positive results from the FS community in this pursuit.

Sure. With with Fixed Income/Bonds, you can sell a bond fund, bond etf, bond index fund, bond motif, for no penalty, except for the trading commission. I’m not giving up 1 year of interest on my 7 year CD at 4.25%.

Creating is not an easy way to make money. Hence, the 6 Feasibility Score. But once you get over the hump, try, and iterate, it is a relatively easy way to make money.

I’ve NEVER been considered the creative one in my family. I’m the financial, right brain one who worked on Wall St, remember? But somehow, I found a way. I think people will surprise themselves.

Sam – Here’s a quick draft…..Formatting got messed up in your editor….Feel free to pretty it up and post it as a guest post if you like…..Sincerely, EarlyRetired

The $20 Trillion Dollar Question

If you owed $2M on your credit card, and simply didn’t have the cash lying around to repay it, what would you do as you tired of paying the interest every month?

• Would you just borrow more?

• Would you try to rally all of your neighbors together in a coalition to make the richest guy on the block pay it off for you?

• Would you get a second job (yuck!).

This is the same question the US government is asking (or at least should be).

What should we do about our $18T in debt that is projected to grow to an astronomical historical high of $20T by the time Obama is finished?

• Raise taxes on the “Rich”? (Um, we already did that; the top 5% now pay 53% of the total income tax. How much more can we “steal” from them before they just quit in exasperation?).

• Borrow more? (Eh hem, interest payments on the debt were $222B in 2013. Does this sound like a good use of our tax dollars? Wanna make it higher?)

• Get a job? (The government doesn’t get a job. They don’t produce anything or sell anything. All they do is redistribute money from those who do – see comment on taxing the rich above).

So what’s left? The one trick that is not available to anyone but the US Government (as the steward of the world’s reserve currency) is to simply inflate our debt away.

Imagine for a moment that we had a repeat of the Carter Administration’s level of inflation. At just 15% inflation per year, our $20T would be magically cut in half in just 5 years! No need for Occupy Wall Street demonstrations. No need for our elected officials to give 1000’s of speeches inciting the rich to “pay their fair share”. Nope, through inflation, there is no debate. No lobbying. Just simple behind the scenes manipulation of numbers on a screen.

So back to our question of what would you do if you owed $2M on your credit card? What would you do to get out of the pickle? Would you take the high road, the hard road, or the miserable road? There is no easy answer.

But if you are the US Government, there is an easy answer. Yep, you just laugh all the way to the Federal Reserve Bank?

But, and there is always a “But”. While inflation may be the easiest political way out of our country’s financial mess, it will come at a significant cost to investors.

Higher inflation means higher interest rates.

How high? It’s hard to say, but certainly in a scenario where our government attempts to make up for the sins of over borrowing by creating inflation, we should expect interest rates to increase enough to hurt.

The key to managing interest rate risk is to not ask the wrong question. Don’t ask what will interest rates be in 2016, 2020 or 2025. Ask if they will be higher or lower than they are today.

Why is this a better question?

• From 1926 to 2013, during months when interest rates fell, the S&P-500 returned 1.2% per month and Long-Term Treasuries returned 1.4% per month.

• During months when interest rates were increasing, the S&P 500 barely broke even and Long-Term Treasuries “lost” almost 1% per month.

“They” say you can’t time the market. But as someone who retired very cushy at 46, I believe it is possible to avoid markets at bad times. This is one of those times.

No you don’t have to pay it back. We will just roll the debt over again and again. We won’t have runaway inflation but we will have 1-2% inflation so 100 years from now the amount we are borrowing will be somewhat inflated away.

We have no insolvency issues by increasing debt as long as we are the world’s reserve currency. We can keep growing our debt at a modest pace forever and ever with no negative consequences. I know this doesn’t sound rational and doesn’t make sense in your example of the individual but this is how it works in the real world.

Hey Ace – Why do you start with an LOL, and then violently agree. The only reason the debt “doesn’t matter” to some politicians is because they believe it can be inflated away. But as discussed above, inflating it away has consequences.

The next time a politician tries to convince you that our debt doesn’t matter, ask yourself why we have taxes. Why not just print more money to pay for everything?

Sam, thanks for providing the link to this article. It has been a beneficial and encouraging read. As we talked about in email, I have actually gone the income producing route of creating a book. In fact, I’m working on two simultaneously, which should be published in January. You are right, there are so many options. I have ebook, softcover, and hardcover editions. Amazon is just the tip of the iceberg when it comes to venues. I have even made arrangements with several retail book sellers to sell copies on commission. One important point I would like to add, is the value of having multiple assets in this channel. I don’t have the exact experience yet, but most of my research seems to indicate that a well-written book, well designed, and well edited that has a target audience should sell well each month. However, several titles doing the exact same thing have the multiple affect in addition to bumping each other up. This is due to readers enjoying one book and going to another as well as publishers, reviewers, and retailers further promoting your slew of publishing.

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